Have You Looked Over Your 2018 1040…Yet?

No? What are you waiting for?

This is where the rubber meets the road when it comes to financial planning. You can’t do proper financial planning until you actually look at one of the biggest, if not THE BIGGEST, cost you will pay in retirement, your taxes.

Don’t believe me?

Let me share with you a real world client situation I dealt with many years ago.

Divorced woman, living in NJ. She was in her 80s. Had a condo, with a mortgage, condo fees, property taxes etc. Needed to get some upgrades done as she was thinking of selling to move to a lower cost area. Trying to sell a condo is a tricky proposition, given ALL the units are basically the same…except for the insides.

If she were to list hers, she’d be competing against other condos for sale which had updated amenities. In her case, she’s not going to win. She either has to list well under the others…or do the updates.

In this case she decided to go ahead and do the updates. Took out $35k from her IRA and didn’t have any taxes withheld.

Previously, she was living on her Required Distributions and her Social Security income. Not living large, mind you, but getting by.

Take a guess what this $35k did to her taxable situation. To put it simple, she had to take MORE out of her IRA the following year in order to pay the taxes, which caused even MORE taxes to be paid from the IRA. A vicious cycle indeed.

She sees her IRA balance going down too and is getting quite nervous. IRA balance going down, taxes going up. No guarantee she’s going to be able to sell her condo for a price she can live with. Worse thing about this situation is there is not a daggum thing she can do about it.

She’s in her 80s, great health, but no way can she go back to work.

This is why tax hedging is SOOO flippin’ important. Having everything in qualified plans, i.e., tax deferred plans, may seem like a panacea. Trust me, my friends, it’s not. It’s far from it as a matter of fact.

What do you do then? Well it starts with your 1040.

Here are the lines you need to look at on the new forms.

Line 15 = TOTAL TAX
Line 6 = TOTAL INCOME
Line 5a = Social Security Benefits
Line 5b = TAXABLE Social Security Benefits
Subtract Line 5a from 5b and add that number to Line 6 to get your REAL TOTAL INCOME.

Then Divide Line 15 by your REAL TOTAL INCOME.

What is your effective tax rate.

Let’s say you have $96k of REAL TOTAL INCOME and paid $7500 in TOTAL TAX.

Your effective tax rate is 7.8%.

In my humble opinion that’s LOW. The chances of that going higher are HIGH. Thus start doing things this year to take advantage of that low tax rate to avoid what could be a much higher one in the future.

Roth conversions come to mind.

Contributing to your Roth 401k as opposed to your Traditional, and tax deferred, 401k.

Maybe sell some stocks for a loss to use those losses against income, 3k per year, or at least against other gains you may have.

Lots to do. Lots to do.

But simply putting your 1040 in the files and never looking at it again won’t help.

Be proactive. It could pay big dividends in the future.

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